Business owners obtain various benefits by setting up a corporation or limited liability company. Chief among the benefits is a corporate structure which shields individual principals from personal liability arising from debt or liability of the company. Frequently, a claimant will attempt to pierce the corporate veil in order to attack the personal assets of a corporate principal or officer. This approach is utilized most commonly when the personal assets of the corporate officers exceed the assets of the actual company.
In New York State, the Courts strongly discourage piercing the corporate veil, preferring rather, to respect the protections afforded by the corporate form. A claimant who seeks to pierce the corporate veil must establish a particularly heavy burden. However, when a business owner’s personal assets (ie. house, car, personal checking account funds, etc.) may be at risk, one can hardly afford to take chances.
The Courts typically look to a number of factors when determining whether to pierce the corporate veil and permit a claimant to attack the personal asserts of a corporate principal. Awareness of these general factors may prevent a claimant from successfully attacking an owner’s valuable personal assets.
I. Corporate formalities
The laws of New York State require corporations to observe corporate formalities. For instance, corporations are required to conduct periodic meetings, maintain records of the meetings, and conduct votes on major corporate issues. Failure to follow these basic formalities can be one of the compelling factors used by courts to justify a piercing of the corporate veil.
II. Commingling of Funds
Avoid using funds in business accounts for paying personal expenses. Furthermore, treat business accounts as entirely independent from personal accounts. Do not transfer money between business and personal accounts. A principal who fails to follow these guidelines will make it easier for a court to determine that the corporation has no true separate identity. Under these circumstances, a court sometimes determines that the company is nothing more than an “alter-ego” of its owner.
It is easy to circumvent the “alter-ego” equation. Open a separate business checking account. Ensure that all business income and expenses flow in and out of this account. If necessary, obtain a business credit card and use it only for business expenses. Keep in mind, personal money may only be taken from a business account as salary, dividends or profit distribution. Make sure every dollar is documented.
Corporations that have little capital are more susceptible to a piercing the corporate veil attack. Although there are no hard and fast rules as to what constitutes inadequate capitalization, if a corporation is merely a “shell” with few or no assets, a court may look to the owner to satisfy corporate debts.
If having your personal assets under siege for debts of your business sounds bad, then be aware of and respect the above guidelines. Failure to follow these basic principles is bad legally and bad for business. Keep good business records, treat your business income and expenses separately from your personal interests and make sure your business has sufficient capital to operate. Observing these practices will not only make for a stronger more viable business, but will also assist you in protecting your personal assets from business debt and liability.